23 November 2012

New recommendations on corporate bonds

A committee established in July 2011 under the former Ministry of Economic and Business Affairs (today the Ministry of Business and Growth) has yesterday issued recommendations on corporate bonds as a finance source for small and medium-sized enterprises (SME's). The committee has analysed the possibilities and the barriers of SME's using corporate bonds as an alternative finance source.

Alternative finance source

The report recommends establishment of the necessary legal framework for securitisation of corporate loans issued by small and large-sized financial institutions. In relation to financing of SME's, the securitisation structure may be applied to create a structured product that will potentially be very attractive to investors and thereby create an advantageous finance alternative for SME's.

The idea is that the SME's affected will obtain small loans with a credit institution (SME loans). The credit institution will thereafter resell the loans to a separate capital entity financing the purchase by issuing secured bonds. The security for the bonds is the instalments of the SME loans. The structure is well-known abroad where e.g. Lloyds Bank in England has made the constructions a core business.

By applying a securitisation model, the risk of the financing of the individual SME's is allocated to the investors willing to undertake the risk of the bonds issued by the separate capital entity. At the same time, the risk premium - and thereby the interest on the corporate bonds - will potentially be notably lower than if the investors had to invest directly in corporate bonds issued by the relevant SME's.

Bill in the pipeline

However, the proposed and intended structure causes a number of problems under Danish law, including the lack of recognition of the trustee role and challenges in connection with transfer of the SME loans to the capital entities. Therefore, it is proposed in the report that a number of measures be taken by the legislator to ensure a more efficient corporate bond market - including a modification of the Instruments of Debt Act, the Bankruptcy Act and the Administration of Justice Act.

The recommendations in the report are to result in a bill expected to be presented in the near future. The bill will reveal the direction in which the corporate bond market will be moving. As the committee has set the stage for various alternative securitisation constructions, it will be interesting to see how the regulatory measures are to be embedded.

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